Italian political gridlock sends markets reeling

(MARKET UPDATE 15:00): Wall Street, which had already booed Italy’s election gridlock yesterday, has resisted the sell-off seen on European stock markets as bargain hunters pushed US shares higher at the opening bell.

Even as European shares remained deeply in the red, the US Dow index opened up 0.7% at 13,879. The S&P 500 was trading 0.5% higher at 1,495.

Markets are racked by uncertainty as investors try to work out what the implications are of Italy’s political uncertainty for the wider euro bloc. They are also awaiting comments from US Federal Reserve chairman Ben Bernanke; his testimony to the US senate will be closely watched for indications of the central bank’s stimulus plans.

Britain’s FTSE 100 remained off by 73 points or 1.1% to 6281, with benchmark indices in Italy, Spain and Germany off by 3.8%, 2.1% and 1.5% respectively.

FTSE and European shares plunge as investors fear return of eurozone instability.

08:41: European stock markets sold off sharply as a political stalemate in Italy raised fears that the country will end up veering off its path of reforms and send the eurozone back into a all-out fight for survival.

Equity markets in Italy and Spain were worst hit, with benchmark indices in the two countries down nearly 4% and 2.7% respectively. Germany fell 2%, while Britain’s FTSE 100 was down by 1.3%, dragged lower by 85 points to 6,270. US and Asian shares also fell overnight.

Italy's borrowing costs soared, with 10-year bond yields rising to 4.9% earlier this morning before dropping back down to a still-elevated 4.7%. The euro, which sold off sharply yesterday, held firm though on Tuesday morning, up 0.2% against the US dollar to $1.3088.The oil price also reflected the fresh economic uncertainty, with Brent crude futures trading down 0.8% to $113.50 a barrel.

Investors were reeling from elections which saw Italians reject the sort of austerity demanded by Brussels and Berlin. Pier Luigi Bersani’s centre-left party won the lower house, but could not beat Silvio Berlusconi’s centre-right party, which has appealed to people’s rage against austerity reforms, to a majority in the senate. Comedian Beppe Grillo also managed huge gains.

A measure of European stock market volatility, the Euro STOXX 50 Volatility Index, hit its highest level so far in 2013 as markets questioned whether Italians would have to return to the polls in the absence of a clear majority.

'It will be very difficult to form a government, and the process may lead to new elections with an uncertain outcome,' wrote Commerzbank analysts in a note to clients. 'Although we do not expect the sovereign debt crisis to escalate, the markets may be very nervous in the weeks ahead.'

Markets have been rallying so far in 2013, with support from global central banks giving investors the confidence to put their cash into riskier assets. But this exuberance has come in contrast to continued economic weakness, especially in Europe, and lingering doubts that eurozone members have made the sort of long-term reforms necessary to fully put the crisis behind them.

Some market watchers warn that the Italian political gridlock could mark the start of the eurozone’s demise. Others are much more sanguine, comparing the current concerns with market fears last Spring – which now appear overblown – that France’s Francois Hollande election victory would seal the fate of the euro.

'We would argue that some further corrective activity is needed to reconcile asset prices to what still amounts to a shaky set of economic fundamentals. That said, the prevalence of cheap money courtesy of the central banks should limit the size of pullback backs,' commented Jane Foley of Rabobank.

Investors sought the comfort of safe havens on Tuesday, with the gold price rising 0.4% to $1,599.

Banking and financial shares across Europe bore the brunt of the stock market sell-off. Italy's Intesa Sanpaolo and Unicredit both dropped by around 8%. In London, Barclays(BARC.L) dropped by 4.3% to 298p. Royal Bank of Scotland(RBS.L) was down by 3% to 422p.

Only a handful of FTSE 100 shares were making gains, led by chemical maker Croda(CRDA.L), which rose 2.1% to 2,612p after reporting a 6.6% rise in full-year profits.

Investors were also tense ahead of comments from US Federal Reserve chairman Ben Bernanke, who will deliver a testimony to the Senate Banking Committee, where investors hope he'll provide clues on the fate of the central bank's monetary stimulus programme.

'If Bernanke was to suggest that the pace of asset purchases could slow, this would mark a major change in the outlook for policy and would prompt significant upward pressure on interest rates and the dollar,' commented James Knightley of ING Bank.

Later this week, markets have the US 'sequester' to contend with, when spending cuts automatically come into force unless politicians reach a deal to avert them.

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